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Equity-Based Incentives Not Executive Loans, Says 'Landmark' SOX Guidance

Joe Mont | March 21, 2013

In a “no-action” letter issued by the Securities and Exchange Commission's Division of Corporation Finance, a firm's use of equity-based incentive compensation was not found to violate a longstanding prohibition on companies providing personal loans to executives.

Responding to RingsEnd Partners, a financial services firm, the Division of Corporation Finance on March 4 wrote that "an issuer that permits its directors and/or executive officers to participate in the EBIC Program would not be deemed, directly or indirectly, to be extending or maintaining credit."

Section 402 of the Sarbanes-Oxley Act generally prohibits a public company from extending or maintaining credit, or arranging for the extension of credit, in the form of a personal loan to its directors or executive officers.

Questions on what does, or does not, count as a “personal loan,” have lingered since the early days of Sarbanes-Oxley, owing in large part to the reluctance of regulators to provide additional guidance. In October 2002, 25 law firms, issued a joint letter to the SEC outlining interpretive issues and requesting greater clarity. Among the arrangements they said should be permitted were travel-related advances. personal use of company credit card (required to be reimbursed), personal use of company car, relocation payments subject to reimbursement, and  “stay” and “retention” bonuses subject to repayment.

An EBIC plan, of the sort sought by RingsEnd Partners, is offered by acquiring equity using funds loaned by a third party, in this case arranged by BNP Paribas, a leading global financial institution.

A Feb. 28 letter to the Division of Corporation Finance from the law firm BakerHostetler, representing RingsEnd Partners, requested interpretive guidance and confirmation that a public company can allows directors and executive officers to participate in an EBIC Program.

Under the proposed program, participating employees will receive shares of their employer's stock as incentive compensation and transfer those shares to an independently-managed Delaware statutory trust. The trust will obtain term loans under a loan facility provided by an independent banking institution, secured by some or all of the employee-participants' transferred shares. The employer will neither encourage nor discourage employee participation.

Michael Oxley, of counsel for BakerHostetler, and namesake of the Sarbanes-Oxley Act, called the no-action letter “landmark interpretive guidance.”

“The SEC staff had never issued guidance on Section 402, and until [now], it seemed highly unlikely that the Division of Corporation Finance would do so,” he said in a statement. “Without interpretive guidance, compliance officers and corporate counsel would be concerned that an innovative program such as EBIC could invite possible enforcement action from the SEC.”

“We concluded not only that nothing in EBIC violated SOX 402, but also that it supported some of the same goals Congress meant to encourage, such as incentivizing company management to act in the long-term interests of shareholders,” he added.